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(Article from Securities Law Alert, April 2015)

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In Janus Capital Group v. First Derivative Traders, 131 S. Ct. 2296 (2011), the Supreme Court defined what it means to “make” a statement for purposes of Rule 10b-5. The Janus Court held that “the maker of a statement is the person or entity with ultimate authority over the statement, including its content and whether and how to communicate it.”[1]

On April 9, 2015, the Second Circuit held the Janus “Court’s definition of ‘to make’ in Rule 10b-5 does not apply to [Section] 17(a)(2)” of the Securities Act of 1933. U.S. Sec. & Exch. Comm’n v. Big Apple Consulting USA, 2015 WL 1566925 (2d Cir. 2015) (Siler, Jr., J.). Section 17(a)(2) renders it unlawful “for any person in the offer or sale of any securities . . . to obtain money or property by means of any untrue statement of a material fact or any omission to state a material fact.” The Second Circuit found that the phrase “by means of any untrue statement” in Section 17(a)(2) “encompasses a broader range of conduct than ‘mak[ing]’ such a statement as defined in SEC Rule 10b-5(b)” (emphasis added by the court).

Background

The SEC brought suit against Big Apple Consulting and its wholly owned subsidiary, MJMM (collectively, “defendants”) in connection with their provision of public relations and investor relations services to CyberKey Solutions, a company that sold customizable USB drives. CyberKey allegedly falsely represented in press releases that it had received a $25 million purchase order from the Department of Homeland Security. The SEC contended that defendants either “knew, or were severely reckless in not knowing, that CyberKey” had no purchase orders from the federal government and in fact “had very little legitimate revenue at all.” Nevertheless, defendants allegedly “persisted in promoting CyberKey and selling hundreds of millions of unregistered CyberKey shares to unsuspecting investors.”

Following a trial, a jury found that defendants had violated Section 17(a). Defendants appealed. Among other arguments, defendants asserted that the district court had erred in submitting the Section 17(a) claims to the jury in light of the Supreme Court’s decision in Janus. Defendants argued that “because they did not have ultimate authority over the content of CyberKey’s press releases, they could not be considered ‘makers’ of any material misstatements and thus could not be liable under the provisions of Section 17(a),” which defendants characterized as “largely coextensive in scope” to the provisions of Rule 10b-5.

Second Circuit Determines Janus’s “Maker” Definition Is Inapplicable to Section 17(a)(2) Because Section 17(a)(2) Is Broader Than Rule 10b-5(b)

On appeal, the Second Circuit rejected defendants’ contention that the Janus Court’s definition of “make” “extends to claims brought under [Section] 17(a) of the Securities Act.”

First, the Second Circuit found “untenable” defendants’ attempt “to import the [Janus] Court’s narrow holding to the entirety of [Section 17(a)]” because subsections (1) and (3) of Section 17(a) ― like subsections (a) and (c) of Rule 10b-5 ― “do not use the word ‘make’ or even address misstatements.” The Second Circuit found the Janus Court “did not alter the potential for liability under Rule 10b-5(a) and (c).” Even after Janus, a defendant “who is not the ‘maker’ of an untrue statement of material fact” could “nonetheless . . . be liable as a primary violator of Rule 10b-5(a) and (c).” The Second Circuit explained it would be “incongruous” to apply Janus “to remove the potential for liability under” Sections 17(a)(1) and (3) given that “Rule 10b-5(a) and (c) [were] modeled” after those provisions.

The Second Circuit also deemed meritless defendants’ contention that “the Court’s holding in Janus should apply to [Section] 17(a)(2)” because “[Section] 17(a)(2) is the analogue to Rule 10b-5(b).” The court explained that the text of Rule 10b-5(b) differs from “the expansive language of [S]ection 17(a)(2).” Under Rule 10b-5(b), a defendant may not “make any untrue statement of a material fact or [ ] omit to state a material fact” in connection with the purchase or sale of securities. Section 17(a)(2), however, prohibits defendants from “obtain[ing] money or property” in connection with “the offer or sale of any securities” “by means of any untrue statement of a material fact or any omission to state a material fact” (emphasis added by the court). While a defendant can only be held liable under Rule 10b-5(b) for “mak[ing]” a material misstatement, the Second Circuit found that a defendant may be liable under Section 17(a)(2) regardless of whether the defendant “use[d] his own false statement or one made by another individual” (quoting SEC v. Tambone, 550 F.3d 106 (1st Cir. 2008)). The Second Circuit “decline[d]  . . . defendants’ invitation to supplant the language of [Section] 17(a)(2) with words taken from” Rule 10b-5(b).

Finally, the Second Circuit found Janus inapplicable to Section 17(a)(2) for the additional reason that the Janus Court addressed the implied private right of action under Rule 10b-5. The Janus Court stated that it was “mindful” of the need to “give narrow dimensions . . . to a right of action Congress did not authorize when it first enacted the statute and did not expand when it revisited the law” Janus, 131 S. Ct. 2296. The Second Circuit explained that “the same concern regarding the expansion of a judicially-created private cause of action” does not apply with respect to claims under Section 17(a)(2) because “there is no private right of action under [Section] 17(a).”